Ducks in a Row, Please

DucksNotInARowI am fairly certain that the spring real estate market turned on last week. Do you know how I know this? I started waking up at 4am without the assistance of my alarm clock, thinking about all of the work that I needed to do, and then getting up to do it. Activating new listings, preparing for more listing appointments for houses that will come on the market, and then the subsequent showings with buyer clients that followed as lots of other agents listed houses too.

This spring market feels very similar to last year’s, although with more of an inventory shortage in March. Buyer clients keep asking when there are going to be more houses to see. My response, “once this freaking snow goes away!” Sellers don’t want snow in their pictures, people tracking dirt and mud into their houses and no one wants to be first to list. So they don’t list and don’t list and don’t list, and then all of a sudden the flood gates open and it seems like everyone lists their house at the same time.

If you are a buyer that is planning to purchase this spring, please get your ducks in a row. There are a lot of you out there and you may be in competition with others for choice properties. That means get pre-qualified by a lender so you know how much you can afford and determine how much you’d actually like to spend. They are very often different numbers. Find a buyer’s agent to work with and start touring houses to get an understanding of the market. This will help you determine what’s really important to you and what would just be a nice-to-have. It will also make you feel more comfortable in making an offer once you find “the one.”

When the market moves quickly, buyers that aren’t prepared will be left behind. Honestly, you snooze, you lose. If you’re thinking you’ll find a house by looking at them casually through open houses, it’s not going to happen. At least not for the properties that are priced well and move-in ready. You’re going to be left in the dust by buyers with agents that can help them write strong offers and that are comfortable with the market.

If you’d like to buy a house this spring, take the necessary steps to do so now. It doesn’t cost any money, only your time, and will make you feel more educated in your decision when you’re ready to move forward.

Rising Mortgage Rates

2013-07-07 YTD Mortgage RatesAs those actively looking for a home can tell you, mortgage rates have risen sharply in the past two months. The chart to the right shows the average rate for a 30-year fixed-rate loan since the beginning of the year. The chart is from the site.

From January through the beginning of May, mortgage interest rates bounced around the 3.5% level. But then, over the course of a little more than a month they increased to over 4.5%.

Buyers have been impacted by the change in a few different ways. Some chose not to lock their rate when they got a home under contract in the spring market, which unfortunately didn’t work out well for them. Others were surprised to be impacted. I know of one case where the buyer’s rate lock lapsed when a closing was delayed and their rate adjusted upwards by a meaningful amount, which also forced them to accept a 3 day waiting period associated with the lender’s required disclosures.

But taking a step back, what should buyers think about rates at 4.5%? The reality of the situation is that from a historical perspective mortgage rates are still very attractive. Have a look at this chart, which is based on National Average Contract Mortgage Rate data since January 1990 from the site.

2013-07-07 Mortgage Rates Since 1990

This chart ends with the May 2013 data point, so it doesn’t show the recent uptick. But still … 4.5% is lower than everything on this chart before the fourth quarter of 2010.

Another way to look at this is by quantifying the impact of the rate increase. Consider a $300,000 home that someone is buying with a 30-year loan and 10% down. Seeing the rate jump from 3.5% to 4.5% causes the monthly principal and interest payment to increase by $156 from $1,212 to $1,368. $156 per month is $1,868 per year, which does not radically change a buyer’s financial equation, but is not an insignificant amount of money either.

The big question about the current interest rate trend is this – how will the real estate market be impacted? Rising rates reduce a buyer’s purchasing power – will this scare some buyers away and force others to reduce their offers? Or will fear of rates rising even higher force buyers off the fence and actually increase demand for real estate?

Bill McBride, author of an economics site called Calculated Risk, has written about the relationship between housing prices and mortgage rates a couple times. In his first piece he noted that the negative impact of rising interest rated is overshadowed by other factors, like the positive impact of a strengthening economy. Most recently he looked at example time periods when the economy was growing at the same time mortgage rates were rising. He found this supported his conclusion that rising rates may slow price gains, but are unlikely to cause home prices to fall.

If you are considering a home purchase, how are you thinking about the rising mortgage rates?

An Offer’s Strength: Financing

How strong is the bid we just submitted for that property you love? Are you going to get the house?

Sellers are receiving multiple offers on a regular occasion this spring. Buyers are lined up, anxious to buy a home, and willing to submit offers on homes as soon as they hit the market. In many cases buyers know they need to write up their best offer immediately – there may not be an opportunity to negotiate.

Multi-FamilyBut how good is that “best” offer?

The first thing the seller is going to look at is the price. They’re going to line up all the bids and look to see who is paying the most money, and how much more the highest bid is over the next highest bid. Buyers can control how much they bid for a home, and pick a number that reflects the property’s value to them.

If more than one bid comes in at about the same price, then the other terms in the offer become more important in the seller’s decision making process. This can be the difficult part for buyers – it comes down to the type of financing and the other conditions proposed for the deal. Most buyers have no control over the type of financing they use, as their cash position and income determine how they can pay for their new home.

Here is how we see sellers rank the strength of competing bids with a similar offer price but different financing terms.

The Cash Offer
Cash buyers don’t have to go through the mortgage underwriting process, which is a big plus for the seller. They may also choose to waive the right to an appraisal, something required by any lender and therefore any buyer using mortgage financing. Since the buyer generally has to demonstrate they have the cash to complete the deal, there is little financing risk to the seller. Sellers might accept a slightly lower bid if it’s cash, but it’s unlikely that they’ll leave too much money on the table. The main risk with a cash buyer is that they may try to be pushy because they have a high opinion of themselves and/or their offer. Cash is attractive, but cash is not king.

Conventional Mortgage with Large Downpayment
Buyers can now get conventional mortgages with as little as a 5% down payment. But realize from a seller’s standpoint, the larger the down payment, the stronger your offer. The smaller the mortgage amount, the more likely it is that you’ll be approved for that mortgage. That lessens the risk to a seller. If you have cash available and know you’re in a multiple offer situation, you may want to increase the down payment component to improve the attractiveness of the offer.

Government Backed Mortgage (FHA, VA, CHFA, USDA)
Government backed mortgages require a small down payment from the buyer, typically 3.5%. These mortgages are also a little more stringent on the appraisal inspection. Sellers usually view them as somewhat more risky than conventional loans because of the low down payment amount and additional appraisal inspection requirement. This type of financing is typically fine if you’re the only bidder. However, if you’re competing against others and there is another buyer with a conventional mortgage, the seller would most likely favor that offer if the rest of the terms in the offer are acceptable to them.

Conventional Mortgage with a Hubbard Clause (House under Contract)
Some buyers already own a property and need to sell it in order to buy their next home. Not everyone can afford or wants to carry two mortgages at once. This is what we locally refer to as a Hubbard Clause – you need to sell your current house in order to buy the next house. Hubbard Clauses are typically viewed unfavorably. Even if your current property is under contract with a buyer, that deal could still blow up for a variety of reasons. The seller of the home you want to buy has no control over your home sale so it’s additional risk. The way to strengthen this type of offer is to come to a seller with most, if not all, of the contingencies on your sale cleared. In that respect, you would be viewed as similar to a buyer with a conventional mortgage with no property to sell.

Conventional Mortgage with a Hubbard Clause (House for Sale, But Not Under Contract)
Typically the only time you’ll find a seller who is willing to take your offer with a Hubbard Clause when your house is not under contract is if you’re the only game in town – when no one else is interested in their house. Otherwise you need to be willing to pay a lot more than others bidding on a property, and show that your house is likely to sell quickly, to capture the seller’s interest.

There are no absolute rules about which type of financing is the best. Each seller is different, and reflects on the different real estate experiences they have had when they evaluate offers.

This ranking captures what we have seen in the market with two caveats. First, money talks, so a high bid can win a home despite less than ideal financing. And second, there are other terms in an offer that could influence a seller’s decision. We’ll review them some other time, but they are almost always prioritized behind the offer price and the type of financing.

Killing the Mortgage Interest Tax Deduction

Reflections at MDC Reservoir 6Speculating that the mortgage interest tax deduction might go away is currently quite popular. News sites all across the internet have taken various angles on what it might mean to individual homeowners and the real estate markets in general.

Most articles argue that eliminating this tax break will cause home values to decrease. The National Association of Realtors is frequently quoted as estimating that home prices would fall by 15% nationally and more in areas with higher prices (like Connecticut). The second most common angle is arguing about who actually benefits most from the tax credit – the “1%” or the “middle class.”

We have three observations:

First, nobody knows exactly how eliminating the tax credit for mortgage interest will impact the housing markets. It’s something that has never happened before in the US, so we can’t look back and see what happened last time. This post on The Big Picture blog is the most succinct summary of the history of the mortgage interest tax deduction that I have found, and has some references at the bottom.

We believe any market, real estate or otherwise, is far too complicated to model with any accuracy. So trying to put a number on the impact of one minor change in the dynamics of the market is unproductive since it’s almost certainly going to be wrong.

That said, we agree that no longer giving homeowners a tax break will tend to push prices in the downward direction. Taxes are an annual cash expense for homeowners, and this could make expenses go up. But there’s no way to quantify how much of an impact annual operating expenses will have on buyers.

Second, our impression is that home buyers are not focused on the tax credit they’ll get from their mortgage interest when they buy a home. We work with buyers all the time and don’t hear them trying to quantify their tax break and figure that into their bids. Most probably know that there is a tax benefit to owning real estate, but it seems like a vague notion rather than a hard dollar amount.

Finally, the value of the mortgage interest tax deduction has decreased dramatically in recent years. Part of it has to do with the decline in property values. Lower prices mean smaller mortgages and less mortgage interest. But the more important factor is the historically low interest rates. It’s common for qualified buyers to have mortgage rates below 4% these days. And many have refinanced into shorter loan terms with even lower rates that have meaningfully less mortgage interest.

For example, a 30-year fixed-rate loan at 6.25% in 2004 (our first mortgage) had annual interest of about $15,000. That same loan today at more like 3.50% would only have $8,300 in annual interest. So the rate environment alone accounts for a more than 40% reduction in the tax deduction.

The decrease can be even more depending on the choices you make. Falling rates have allowed us to refinance multiple times, and annual interest on our current loan is less than $6,000 per year. It’s the same house, with a slightly lower principal balance, a much lower interest rate, a shorter mortgage term, and a higher monthly payment. So the market, combined with our personal choices, has reduced our mortgage interest tax deduction by about 60% since 2004.

The residential real estate market will continue to exist and function whether mortgage interest is tax deductible or not; people will still need to buy and sell homes. Changing the rules of the game will always have an impact, but it is impossible to quantify just how much one factor will influence how buyers bid for homes. It’s fine to want this particular program to continue – we all want to minimize our taxes/expenses. But it feels like most are overstating the importance of the mortgage interest tax deduction by suggesting killing it off could ruin the recovering housing market.

Mortgages: Purchasing Power versus Conservatism

We’ve been thinking a lot about mortgages lately. Something that jumps out at us is just how much of an opportunity the combination of declining mortgage rates and falling home prices has created for buyers.

Interest rates for 30-year fixed mortgages were around 6% during the early and mid-2000s when we bought our house. Those same loans are now available for interest rates of 4% or less, and 15-year fixed mortgages are available for just over 3%.

But what does this mean in practical terms? How can a buyer use this to their advantage?

First, consider a buyer with fixed monthly budget for the principal and interest payments of their mortgage of $1,800. Here is how much a buyer could pay back in the mid-2000s for a home within the $1,800 per month budget if they had the cash for 20% down, 10% down and 3.5% down.

30-Year Fixed mortgages from the mid 2000s

I don’t know how much interest rates varied based on the down payment amount back then, so that assumption may not be exactly right. But I am often surprised that in today’s market everyone gets a very similar interest rate no matter how much the put down – as long as their credit is good – so let’s go with it for now.

Fast forward to today … how much additional purchasing power does a buyer have when lower interest rates are factored in? Keeping the monthly budget at $1,800 we can see that the buyer with 20% down can spend almost $100,000 more. Which, when the falling prices are considered, is a meaningfully better home than they could get for the same monthly payment in the mid-2000s. Those with 10% and 3.5% down also see a bump in their buying power and an ability to get into a nicer homes.

Today's 30-year Fixed Mortgages

Buyers also have the option to go more conservative. Rather than using low interest rates to increase their purchase price, buyers can instead cut the length of their mortgage in half with a 15-year fixed rate loan.

Current 15-Year fixed mortgages

The shorter mortgage does decrease the amount that buyers can spend, but some of that decrease is offset by the declines in market values since the mid-2000s. Sticking with the 20% down buyer, they are now looking at a $320,000 home instead of a $375,000 home. In most local towns that will not be quite as nice a property, but it’s a modest step down rather than a dramatic one. Is it a worthwhile tradeoff for debt averse buyers? Definitely.

It’s an interesting exercise to consider the possibilities, though not a perfect analysis. We’ve excluded the property tax and homeowners insurance escrows for the moment, since they vary from town to town. Both have undoubtedly risen since the mid-2000s, and do factor into the monthly budget. Even so, there is still an opportunity here.

Most buyers seem to be sticking with the 30-year fixed loan for their purchases. Existing owners tend to be the ones refinancing down to the 15-year mortgage, cutting 10 or more years off their loans while taking on a modestly higher payment.

My parents said something over the weekend that put this in a different kind of historical perspective. We were talking about the short-term rate of less than 3% that we’re trying to take advantage of, and they noted that they had never had a mortgage rate of less than 8% on any of their homes. Kinda makes the 6% and change where we started our journey seem reasonable…


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The Appraiser is Coming!
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Refinancing Our House
Refinancing Our House – Journey Underway
Refinancing Our House – Journey Completed
Mortgage Rates are Low
To Refinance or Not to Refinance (Part 1)
To Refinance or Not to Refinance (Part 2)